China’s Economy: The Second Quarter

New data shows growth in China’s economy in the second quarter slowing to the lowest rate since the financial crisis. Though not unexpected, the latest numbers suggest a lackluster global recovery may not be able to rely on China for much support.

What’s driving the slowdown and what can the government do about it? China Real Time lays it out.

Growth in China’s gross domestic product dipped to 7.6% year-over-year in the second quarter, down from 8.1% in the first and the lowest level since the beginning of 2009.

On an annualized quarter-over-quarter basis – the way in which growth is measured in the U.S. – the picture was slightly different – with the growth rate lower but signs of a rebound from the first quarter.

Based on the NBS numbers, annualized QoQ growth in the second quarter was 7.4%, up from 6.6% in the first quarter after a revision to the historical data.

Differences of opinion on the true QoQ growth rate remained.

Wang Tao, China economist at UBS, calculates that the sequential growth rate is actually about 7% in the second quarter, some way below the official figure. Song Yu, China economist at Goldman Sachs, also puts the QoQ growth rate at 7% in the second quarter.

The composition of growth – a major concern for China’s investment-heavy economy — showed some signs of improvement. Consumption contributed 57.7% of GDP growth in the first half, up from 47.5% in the first half 2011. The share of investment came in at 49.4%, down from 53.2% in the same period in 2011.

A contracting European economy and weak recovery in the U.S. took the wind out of exports’ sails and were key contributors to the slowdown.

Export growth faded to 11.3% on-year in June, down from 15.3% in May. Exports to Europe fell 1.1% on-year, as the U.S. overtook Europe as China’s biggest export destination.

Mr. Lu, a marketing officer at a toy company in southern export hotspot Dongguan, said resilient domestic demand for their products had helped offset weak exports. “Domestic demand is quite supportive” he said, “that has helped us avoid any big layoffs of workers.”

With import growth also weak China’s trade surplus swelled. A $31.7 billion trade surplus in June was the largest since the beginning of 2009.

Despite that, yuan appreciation has swung into reverse. China’s currency is now depreciating against the dollar at an annualized rate of around 2.5%. With China’s undervalued yuan blamed for the loss of U.S. manufacturing competitiveness and jobs, that creates a potential problem for President Obama in an election year.

At home, the real estate sector remained the villain of the slowdown drama.

Two years of government controls means falling property sales and investment, taking a chunk out of demand for everything from steel and cement to furniture and fridges.

Numbers from property agency Soufun show an uptick in prices in June – the first after nine straight months of declines.

If there is a turnaround in real estate, though, it has not yet fed through into stronger demand. Area of new residential property under construction fell 19% on-year in June, down from a 9% fall in May.

Electricity output – often viewed as a reliable proxy for the overall growth rate – continued to shock. Output was flat from a year ago.

Responding to suspicions that even those low voltage electricity growth data are exaggerated, NBS spokesman Sheng Laiyun said the data was accurate. “We get data from the grid and direct from companies and the two data sets match,” he said. Mr. Sheng blamed falling growth in heavy industry, and ongoing efforts to improve energy efficiency, for weak electricity production numbers.

The main victims of fading growth are firms in the construction materials sector. Giant cement mixer Anhui Conch warned that their net profit is likely to drop 50% on-year in the first half.

Auto sales growth also stayed in the fast lane, with the Chinese Association of Automobile Manufacturers reporting 9.9% growth in June, down from 16.2% in May, but better than the close-to-zero growth seen in the first quarter.

Stable consumption growth was underpinned by tight labor markets and continued increases in wages.

A survey of more than 4,000 firms by Manpower Group, a human resources consultancy, found that the majority of companies intended to either hold their workforce stable, or recruit more workers in the third quarter, with just 3% planning job cuts.

An analysis by Manpower suggested employers are anticipating more moves by the government to support growth, so they are holding onto their employees.

Falling inflation provided a ray of light for China’s government in an otherwise gloomy data set. The consumer price index fell to 2.2% on-year in June, its lowest level since January 2010.

That opened up space for the People’s Bank of China to cut benchmark interest rates for a second time since the beginning of June. For some borrowers, the one-year lending rate has now fallen from 5.9% to 4.2% – a substantial drop.

The response appears to have been immediate, with bank loans up substantially to 919 billion yuan ($144 billion) in June, from 793 billion yuan in May.

But a disappointing tally for the medium- and long term loans used to drive investment – 163 billion yuan in June after 169 billion yuan in May – suggests businesses are still cautious about starting new projects.

A loan officer for a major state owned bank, who asked not to be named, anticipated better news to come. “We’re not seeing much of an impact from the rate cut so far,” he said, “but big state-owned firms are already borrowing at a 20-30% discount to the benchmark interest rate, and so there will be an impact on loans in the second half.”

Anyone hoping for a return to the glory days of double-digit growth is likely to be disappointed, though. Chen Dongqi, Vice President of the National Development and Reform Commission’s Academy of Macroeconomic research, said he expects GDP growth to come in below 8% year-over-year in the third and fourth quarters, with growth for the year as a whole between 7.5% and 8%.

“China’s potential growth rate has fallen,” said Mr. Chen, “7%-8% is the new normal.”

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